Financing the institutionalization of crypto mining
The cryptocurrency mining industry is currently undergoing a remarkable transition. As it becomes ever more evident that cryptocurrencies are a fundamental building block of the future financial system, the core infrastructure underneath these networks is becoming increasingly institutionalized. Geographic shifts in Bitcoin mining, a cohort of new players seeking exposure to the mining market and focus on clean energy sources are the driving forces behind this transformation. In this new market environment, mining businesses are turning to asset-backed financing solutions to scale and gain a competitive edge.
The institutionalization of crypto mining
A strong mining network is of fundamental importance to the security of a blockchain. It functions as an essential safeguard to the trustless properties of the respective system. Out of all algorithms, Proof-of-Work mechanisms still offer the best defence against Sybil Attacks and thus the highest degree of trust-minimization. Utilizing as much energy as the market is willing to allocate to these networks is a testament to their respective security and economic importance in the world. The crypto mining industry represents the picks and shovels to enable these networks to succeed.
The institutionalization of the crypto mining industry will open up miners as an investable asset class to a much broader market and potentially catalyse another boom cycle. As Preston Byrne predicts, “just wait until we see the first securitizations backed by mining receivables”.
Crypto miners are on the move. Following the Chinese government crackdown in June 2021, datasets from the Cambridge Centre for Alternative Finance show the geographic shifts in Bitcoin mining and China’s sharp decline. Accordingly, China’s share of total Bitcoin mining hashrate had already declined from 75.5% in September 2019 to 46% in April 2021, before restrictions were even imposed. In the same timeframe, the United States’ share of the total Bitcoin hashrate grew from 4.1 to 16.8% followed by Kazakhstan with 8.2%. These developments are reshaping the competitive mining landscape and opening a window of opportunity to drive the institutional adoption forward.
One such opportunity is the increasing usage of renewable energy sources in the energy mix of crypto mining. While the mainstream narrative surrounding mining energy expenditure is still predominantly painted in negative context, more and more datasets point to the opposite. The latest report by the Bitcoin Mining Council highlights that bitcoin mining uses a negligible amount of energy, is rapidly becoming more efficient, and is powered by a higher mix of sustainable energy than any major country or industry.
Moreover, cryptocurrency mining can even be an economic means to bootstrap the exploitation of renewable energy. According to Mike Colyer, chief executive of Foundry, bitcoin mining can be “a bridge between our current energy production and this future world of renewable energy production.” By helping renewable projects manage oversupply and supporting more investment, crypto mining can become a core driver of the transition towards renewable energy.
Major players and new market entrants are already laying the groundwork in addressing the environmental, social and governance (ESG) issues that might deter big institutional investors from entering the market. Traditional investors such as BlackRock, the world’s largest asset manager, already disclosed to have exposure to the market. In May, CoinShares, a digital asset investment firm, said that it had made a strategic investment in Viridi Funds and that it will advise the manager on “the first ESG crypto mining product in the U.S.”. In September, Blockstream partnered with Macquarie to explore renewable Bitcoin mining solutions. Just recently, Crew Energy Inc. was the first publicly traded oil company to acknowledge they are mining bitcoin for greenhouse gas emissions reduction.
Competitive edge through asset-backed financing
Renewable energy is most often the cheapest source of energy. Miners are always driven to find ways to become more efficient. The cost structure of mining businesses is split between upfront investments and ongoing cost, capital expenditures (CAPEX) and operating expenses (OPEX) respectively.
These include state of the art mining machines, energy expenditures, warehousing cost, personnel payroll, and other overhead costs. In return for providing the processing power to blockchain networks, miners are rewarded with a predictable passive revenue stream of cryptocurrency. Crypto mining has always been and will continue to be increasingly competitive. Besides incorporating the latest technology and cheapest source of energy, miners are increasingly turning to structured financial products to gain a competitive edge.
Asset-backed financing allows miners to leverage their physical and digital asset inventory. By receiving upfront capital against their mining machines or mining accounts receivables, crypto miners gain working capital and liquidity to strengthen their competitiveness. This allows mining farms to expand, increase their hashrate or cover operational costs. Treasury management can be optimized and taxable events via sales of cryptocurrencies avoided. As cryptocurrency prices can fluctuate dramatically, the need for predictable cash flow is critical to operate an efficient and competitive business. In the case of asset-backed securities, mining companies can potentially move their mining rigs entirely off their balance sheets, transforming asset-heavy miners into asset-light, low-risk service providers.
The market is already signalling that asset-backed financing is an attractive solution. In June, Poolin announced to expand its offering of financial services to miners with support from BlockFi, starting with bitcoin-collateralized loans. Earlier this year, NYDIG acquired Arctos Capital, a technology-driven commercial lender that provides financing solutions to bitcoin holders, investors, and mining businesses. Until that point, Arctos Capital provided multiple loans to mining companies. Babel Finance is another service provider offering machine collateralized loans to crypto mining firms, which already accounts for a significant share of the company’s total outstanding loans.
The evolution of asset-backed financing
Asset-backed financing is a specific method of providing a business with a loan that is secured by one of the company’s assets. These assets can include accounts receivables, inventory, machinery, or real estate as collateral. In the event of a default, the lender can recoup their investment by seizing and liquidating the assets tied to the loan. Categories of asset-backed financing include asset-based lending, commercial finance as well as asset-backed securities.
Originally considered a last-resort finance option, asset-backed financing is increasingly becoming an attractive option for a variety of companies. For businesses where traditional options of raising capital and taking out loans are scarcely available, asset-backed financing can be a crucial instrument. This particularly affects companies operating in nascent industries such as the crypto market, which is structurally underserved by the traditional financial system.
There are multiple projects seeking innovative ways to advance asset-backed financing solutions within the crypto ecosystem. Centrifuge is one of the leading players in the field of bringing Real World Assets on-chain and unlocking liquidity for asset originators. Its’ protocol allows to bridge assets like invoices, real estate, and royalties to Decentralized Finance for borrowers to take out loans against these tokenized assets. Another exciting project regarding asset securitization for the mining industry is the Blockstream Mining Note (BMN). By securitizing hashrate on the Liquid Network, investors can adjust their exposure to Bitcoin mining based on market conditions by trading the BMN tokens on the secondary market. In a similar manner, Titan Network proposes a tokenization scheme for hashrate to be utilized in further financial products and trading activities.
At Tokenfabrik, we welcome all initiatives building decentralized financial infrastructure and contributing to the security of the Bitcoin blockchain and other networks. Financial innovation in asset-backed financing will fundamentally support the institutionalization and growth of our industry’s physical base layer, the mining network. We are collaborating with leading mining companies, DeFi protocols and legal professionals in developing a seamless, simplified and global protocol that enables simple and transparent asset financing for miners.
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This article was written in collaboration with Dennis Schlegel. We want to thank him for contributing to the Tokenfabrik ecosystem and community.
